XLF - IYF: A Rotation Out Of Tech Alongside Steepening Yield Curve Helps

2024-01-18 15:53:47 ET

Summary

• Financials have been performing similarly to Technology for several months, indicating a potential rotation opportunity.
• Financial stocks can benefit from a steepening yield curve, increased demand for loans, and attractive dividend yields.
• iShares U.S. Financials ETF offers a low-risk and diversified exposure to the Financials sector, but may not be suitable for all investors.

Did you know that Financials relative to Technology have performed the same now for several months, as the price ratio between iShares U.S. Financials ETF (IYF) and Technology Select Sector SPDR® Fund ETF (XLK) proves?

I'm negative on Technology, and think Financials could outperform for the year (which just means up more or down less). If I'm right, the iShares U.S. Financial ETF is one way to play that rotation.

But why now? Financial stocks often benefit from a steepening yield curve, where the spread between long-term and short-term interest rates widens, potentially leading to improved net interest margins for banks and higher profits. Furthermore, as economies expand, demand for loans and financial services increases, which can drive revenue growth for financial institutions. In addition, financial stocks typically offer attractive dividend yields, appealing to income-focused investors. Considering these factors, financial stocks can offer both value and growth prospects, making them an attractive addition to an investment portfolio, particularly for those with a positive outlook on the economic cycle and interest rate landscape.

Launched on May 22, 2000, IYF is a passive fund designed to offer investors a broad exposure to the Financials - Broad segment of the equity market. Managed by BlackRock, one of the world's leading asset managers, the fund seeks to mimic the performance of the Dow Jones U.S. Financials Index before fees and expenses.

The fund had amassed assets over $2 billion, making it one of the largest ETFs in the Financials - Broad segment. The fund's expense ratio stands at 0.40% annually, which is in line with most peer products in the space. Over the past year, IYF has generated a trailing dividend yield of 1.67%.

Detailed Composition of IYF's Holdings

The largest holding in the fund is Berkshire Hathaway Inc. Class B (BRK.B), which makes up about 12.80% of the total assets. Following Berkshire Hathaway are JPMorgan Chase & Co. ( JPM ) and Bank of America Corp (BAC). The top 10 holdings collectively account for about 45% of the total assets under management. The fund is relatively diversified with around 143 holdings, effectively mitigating company-specific risks.

Comparing IYF with Peer ETFs

When it comes to investing in Financials ETFs, investors have a plethora of options. Two notable competitors to IYF are the Vanguard Financials ETF ( VFH ) and the Financial Select Sector SPDR ETF ( XLF ). VFH tracks the MSCI US Investable Market Financials 25/50 Index while XLF follows the Financial Select Sector Index. Both VFH and XLF charge a lower expense ratio of 0.10% compared to IYF's 0.40%. The 3 have largely performed in-line with each other.

Pros and Cons of Investing in IYF

Investing in the iShares U.S. Financials ETF comes with its own set of advantages and disadvantages. On the positive side, IYF offers investors a low-risk and diversified exposure to a broad group of companies in the Financials sector. It is passively managed and has a relatively low expense ratio, making it a cost-effective option for long-term investors.

On the downside, the fund's heavy allocation to the Financials sector might not appeal to investors seeking a more balanced and diversified portfolio. Additionally, the fund's performance is closely tied to the overall health of the U.S. economy, making it susceptible to economic downturns.

To Invest or Not to Invest

While the iShares U.S. Financials ETF offers a convenient way to gain exposure to the Financials sector, it may not be suitable for all types of investors. Those seeking a diversified and balanced portfolio might find the fund's heavy allocation to the Financials sector unattractive. However, for investors bullish on the U.S. financial sector and seeking a cost-effective and low-risk investment option, IYF could be an excellent choice.

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